INVESTORS SCURRY FOR NEW BENCHMARK

What's an investor to do? For better than a quarter century, investors of all stripes have looked to the 30-year U.S. Treasury bond as the benchmark against which to judge all other investments. But that benchmark is in tatters. So where should investors, particularly bond buyers, turn to now for safety?

Understand first why this has come about. At the moment, the U.S. government is using its budget surplus to buy back its most expensive debt-that's the 30-year Treasury bond, known as the "long bond." This situation may change, of course, in the event the surplus disappears in a weakening economy, additional government spending eats up the surplus or tax reductions shrink the surplus. But for now, the Treasury is buying up the long bond.

Why should you care? The long bond provided the benchmark for much of the credit market, from mortgages to AAA corporate bonds to high-risk junk bonds. It reflected expectations of future interest and inflation rates. It also served as the "risk free" proxy that other types of bonds and investments, such as stocks, were measured against. Why take the risk of buying a stock if it's barely returning better than Treasuries? (Actually, while Treasuries are free of default risk, they can lose principal unless you hold them to maturity.) Retirees, pension funds and foreign investors especially liked 30-year bonds, and shorter-term Treasury securities, because they provided stability and steady income.

But as the supply of 30-year Treasuries shrinks, they are becoming more volatile. And they are not even returning particularly well. Generally, 30-year bonds pay a higher interest rate than shorter-term Treasury securities because longer-term bonds are more risky when interest rates change. But in part because of the government buy up, shorter-term bonds currently offer higher yields than the long bond-a situation known as an inverted yield curve.

Thirty-year Treasury bonds aren't going to disappear. But bond investors looking for a fixed-income benchmark, and bond investors seeking stability and better returns, may want to look at alternatives. Here are a few.

Ten-year Treasury notes. In May, The Wall Street Journal announced that the ten-year Treasury note would henceforth serve as its main gauge of the U.S. bond market. This reflected the growing position of the ten-year in the marketplace, such as the benchmark against which mortgage rates are now set.

Ginnie Maes. These securities issued by the Government National Mortgage Corporation are based on pools of mortgages issued by government agencies. They typically yield better than Treasury securities-a high 1.5 percent better around the end of May-and they are backed by the full faith and credit of the U.S. government. Ginnie Mae certificates are expensive for individual investors-$25,000 each-and payments include a return of principal. Small investors might want to consider mutual funds that buy Ginnie Maes, though principal is not guaranteed in a fund.

Fannie Maes and Freddie Macs. These are mortgage-backed securities, like Ginnie Maes, sold by the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation. They have implied government backing, but not the full faith and credit of Treasuries or Ginnie Maes. There's been some discussion of cutting Fannie Maes and Freddie Macs entirely from the government. Unlike Treasury securities, mortgage-backed securities, including Ginnie Maes, face the market risk of early repayment of the mortgages through home sale or refinancing. They also are subject to state and local taxes, unlike Treasuries.

Corporate bonds. Before Treasuries became the benchmark in the late 1970s, the bond market used top-graded corporate bonds for their benchmark. Corporate bonds carry credit risk, unlike Treasuries, but provide higher returns. Bond mutual funds often are the best way for smaller investors to buy corporate bonds.

The obscure. Numerous other government agencies issue bonds, including the World Bank, the Agency for International Development and even ship-financing bonds. While backed by the government, these bonds are not very easy to sell or buy because their markets are so small. Mutual funds may be the best way to go in this case.

While 30-year Treasury bonds remain sound investments, bond investors may want to talk to their investment advisor to see if diversification are more appropriate.